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VC Bundling.html
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<p>
Microsoft bundles its Office applications. Record Labels and Game
Publishers bundle cash and distribution. Silicon Valley Venture Capital
bundles Advice, Control, and Money. In lean times, you, the entrepreneur,
have to buy the bundled good.
</p>
<p>
Want Cash? It comes bundled with an Advisor on your Board of Directors,
like it or not. And they take Control.
</p>
<p>
Want Advice? VCs won’t take Board seats without putting in Cash – it’s the
only way to get enough leverage. And they take Control. Always the
Control.
</p>
<p>
Smart entrepreneurs in times of plenty (like our current financing
bubblet), serial entrepreneurs, and those with profitable businesses break
apart these bundles. To un-bundle, you must have multiple bidders (that’s
a longer entry), and you must have the ability to refuse capital (on Sand
Hill Road, collusion is just a lunch away).
</p>
<p>Let’s break apart the bundle.</p>
<ul>
<li>
<p>
Cash – you want this on the best terms possible. The brand is
irrelevant here. Kleiner Perkins and Sequoia have built their brands
by generating huge returns for their investors first and foremost, but
at least a portion of that comes from undervaluing
<em>your</em> startup. Best terms means a great valuation, small
up-front option pool (you can always issue more later, diluting
everyone, not just the pre-money common), small liquidation preference
(1X, non-participating), and weak anti-dilution. You do have to be
careful in that your investors will block exits that don’t make them a
certain minimum rate-of-return on their investment, so you probably
shouldn’t take money at a valuation higher than 1/3 of what a modest
exit looks like.
</p>
</li>
<li>
<p>
Advice – Suppose that you have a brilliant investor on your Board. The
in-demand investors are on about 8-10 Boards. They spend about half
their time looking for new deals. And being older and having money,
they usually spend more of their time on philanthropy, social events,
vacations. Meaning that, if you’re lucky, they allocate one solid
business day per company per month, and usually not even that. That’s
barely enough time to keep up-to-date with what you’re doing, let
alone “build the company.” Be pragmatic and select your investors for
good judgement, unity of vision, and for their humility and
willingness to treat you as peers (you’ll have to look long and hard
for that last one). If you want “Value Add,” that can be purchased
more cheaply elsewhere – an external Board member can be hand picked
and will cost a small fraction of what an expensive VC will, and comes
without the Control. If you’re looking for someone to “open doors,”
that almost never works. Big companies deal with you based on your
merits, momementum and timing, not based on which big-shot happened to
introduce you. A side-note: the individual VC partner on your Board
matters a lot more than the firm’s name does, so write the partner’s
name into the termsheet, and if that partner leaves the firm, make
sure that you have to consent to the replacement.
</p>
</li>
<li>
<p>
Control – Ay, here’s the rub. A once-a-month part-timer with
mis-aligned incentives (different class of stock) and an MBA, who
controls your destiny. To minimize control, assemble your investor
syndicates yourself, retain Board majority if you can, or at least
give the outsider seat to a truly unbiased advisor, and don’t be
afraid to exert independence when needed. If you’re moving around
Powerpoint formats to please your Board members, you’ve already lost
this one… Realize that even minority shareholders can sink future
financings by not participating, so VC investors will always have more
control over the company than you might like, so you have to
constantly work at keeping an alignment of incentives.
</p>
</li>
</ul>
<p>
Google did a masterful job with this – Larry Page and Sergei Brin raised
money at a high valuation, insisted on the best advisors (Doerr and Moritz
– no unbundling here), and kept control of the company, the CEO
recruiting, and the going-public process throughout. Rumor has it that at
one point, the VC investors, un-accustomed to taking a back seat, were
offered their money back! Needless to say, they didn’t take it.
</p>
<p>
I realize that I’ve used a lot of industry jargon here. If you’re unsure
of the meaning of something, or have questions, just post a comment below.
</p>
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